Rudolf Siebel, Managing Director of BVI Bundesverband Investment und Asset Management, shares the perspectives of German asset managers and their needs and goals for the coming year.
Technology and Trading Costs BVI represents German investment fund and asset managment industry which manages ¤1.7 trillion in assets such as bonds, equities and derivatives. Trading is an issue dear to our hearts. In particular, we welcome the improvements in electronic trading over the past decade especially those based on standards, such as the FIX Protocol, which enable automation based on standardization. That is one of the reasons why we became part of the FIX community in September 2011. Costs of trading have certainly fallen over the past few years, particularly with regard to the costs charged by brokers and venues. Also, trading costs have been implicitly lowered through a reduced market impact. Our members sense that with electronic trading they can be much closer to the market and limit the loss of market value because of the latency in trading. Our members, however, have seen that the cost of support and analytics has not fallen. Some also believe that the buy-side trading volume side had declined and that the sellside volume is on the increase.
Value through Innovation Having discussed issues of electronic trading within our industry, I think the increased ability to analyze market impact and trading costs has provided value. Over the past few years, our membership has seen value shift very quickly to better market access, especially through smarter routing technology. Based on mutual studies, only about 65% of the turnover of the DA X is now on the Deutsche Boerse, and for the FTSE 100, only 50% is now on the LSE. It is absolutely vital for our members to be able to access different liquidity pools, whether lit or dark. Smart algorithms have become a main issue, but not necessarily in view of improving low latency. Our members are asset managers who base their decisions on the selection of securities and asset classes, not necessarily on squeezing out each latent nanosecond. As a result, low latency trading is a secondary priority for BVI’s members, but smart order routing is obviously important given the large number of venues in the European market. At my latest count, there are about 70+ different types of trading venues, be they exchanges or other trading platforms.
Volatility and Connectivity We are now in a market where there are no longer any safe havens among asset classes, and in times of high market volatility it is absolutely necessary to link your internal systems to outside trading platforms in order to be flexible and quick to market. German asset managers have yet to establish connections across asset classes, and the FIX Protocol is very important as a basis for discussing the connectivity issue. Going forward with Dodd-Frank and new regulation on the European side, the the connectivity with Central Counter Parties (CCPs), will also be a big issue for 2013 and 2014. As far as it is possible, connecting to all markets and asset classes in an electronic way, and connecting to more CCPs will be the challenge for next few years.
Nomura’s Jeremy Bruce summarises the current state of play in terms of European liquidity venue fragmentation, and focuses specifically on venue ownership and geographical concentration of equity execution venues.
Ownership and Location of European Equity Trading Venues
In the past few two years we have seen not only increasing liquidity fragmentation in Europe, but a significant change in the pecking order of exchange and venue size. The diagram below lists all venues with a market share of greater than 1% as well as referencing other smaller venues. As can be seen, it shows both the rise of venues, such as Chi-X Europe and BATS, as well as the proliferation of light and dark venues owned by the preexisting exchanges. Chi-X Europe in particular, is now comfortably the largest pan-European venue. There are currently two proposed mergers on the table, firstly between NYSE Euronext and Deutsche Boerse, and the second between Chi-X Europe and BATS.
The old model of a country having a primary exchange located within its borders (normally in the main financial district), where its companies’ stocks almost exclusively trade is no longer relevant. As corporate ownership of the manifold liquidity venues becomes more complex and blurred, it is perhaps more meaningful to look at the actual location of the exchange. When we say exchange, we are actually referring not to the administrative or corporate headquarters of the exchange firm, but to the location of the IT infrastructure that runs the actual live exchange matching engine. This location is then a physical data centre building, with an additional failover backup site.
Deutsche Börse’s Hanno Klein, Co-Chair of the FPL Global Technical Committee, expounds on the role of FIX semantics in standardised access to trading and clearing services.
Why are Interface Semantics Important?
Semantics represent the look and feel of an interface from a nontechnical perspective, but can influence overall implementation and testing effort much more than the syntax. If you will, semantics are the interface language and standardization is about speaking the same language, for example FIX.
The Difference between the FIX Syntax and FIX Semantics
Syntax is the encoding of bits and bytes on the wire; for example, whether you use ASCII or binary values for numbers or whether you have a FIX tag=value syntax or an XML syntax like FIXML. The syntax consists of messages, components, fields and valid values that are the building blocks for the semantics. FIX semantics is about the business functionality and how it is expressed within the building blocks of FIX. FIX Semantics relates to the elements with which information is conveyed and about the flows through which these elements are passed back and forth between two or more parties. Let me give you some examples.
A combination of “35=D” and “35=8” is the tag=value syntax for the semantic “submission of a new order for a simple instrument followed by a confirmation or rejection being returned”. Readers probably know these tags by the more familiar terms NewOrderSingle and ExecutionReport.
59=4” is the tag=value syntax for the semantic “order needs to be filled completely upon entry or cancelled immediately”. The FIXML syntax for the same semantic is TmInForce=”4”.The corresponding term for the order, Fill-Or-Kill (FOK) is a well known part of the FIX language.
“38=1000|1138=100|1083=1|108 4=3|1085=50|1086=80” stands for “reserve order of 1000 that is to be displayed initially with 100 and to be replenished whenever a fill occurs with a randomly chosen quantity between 50 and 80”. Some might be more familiar with the term “iceberg order” which is not used by FIX.
The mapping of semantics to syntaxis not trivial and standardization is about using the same map for the same semantics to ease the burden for the software developer and reduce costs.
How can FIX semantics be used more effectively?
Greater effectiveness will come through an increasing awareness of the importance of FIX semantics for true standardization. FIX training courses could be offered with a focus on semantics and put less emphasis on the technical aspects of the protocol such as the encoding or the session layer mechanics. Usage guidelines for new and existing functionalities can help to understand the semantics behind FIX message layouts.
Without semantics it is impossible to determine which FIX fields or valid values will be present in which contexts. The syntax will merely show all possible values of a field, which may be sufficient for the developer, but not for the person who then wants to test the interface.
Paul Squires, Head of Trading, AXA Investment Managers opens up about the relationship between the buy-side and exchanges, and the perceived effects of recent consolidation among exchanges.
From Trading Desk to Trading Floor
We trade on an exchange in the name of a broker, which means there is a buffer between the exchange and the buy-side. The interaction we have with the exchanges and MTF’s works much better now. The MTF’s have done a good job engaging with the buy-side over the past few years, which makes a lot of sense when you think of the evolving landscape of market structure. Historically, buy-side firms and exchanges were never quite sure if they needed to pay much attention to each other; however, there is a much more collaborative dialogue now. Most buy-side desks have mixed feelings about some of the bigger exchanges, in much the same way that some of the brokers have mixed feelings about the positioning of exchanges. On the up-side, there is a sort of national, utility element to the exchanges. For things like index funds, primary exchanges own the end of day official pricing.
Before MiFID, the primary exchanges were responsible for more of the trade and transaction reporting and it was easier to interpret that data compared with the fragmentation of trade reporting following the first MiFID installment. On the buy-side, we have this simplistic view that it is positive for reporting to be centralised through the primary exchanges because having liquidity in a single venue is something we see as beneficial. Also, the level of monitoring around the primary exchanges is higher than around the MTF’s, and therefore, things like governance and robustness tend to be greater. Generally speaking, we see the primary exchange as a kind of trustworthy elder statesmen in the world of market structure. Where I think the challenges around the exchanges lie are that innovation can be bogged down by their hierarchy and organizational structure, and therefore, cannot compete quite as dynamically as some of the MTF’s, which clearly have much lighter infrastructure considerations. It is no surprise that some of the primary exchanges have lost market share to the MTF’s, who have been nimble, technology focused and reactive in the face of a changing environment.
We find it quite fascinating to see what will happen. Given the rate of market expansion, globalization and regulatory changes - all of which lends itself to consolidation - it was an inevitability. Exchanges have to be forward thinking about what their long term roles will be and although there are different aspects to this, what we tend to focus on is cash equities only. When people think of the Toronto or London exchanges merging, they think it is kind of interesting. Deutsche Boerse and NYSE Euronext, on the other hand, is fairly mind-blowing. In a wider context, the really interesting developments for us, the market participants, are for exchanges to look into other asset classes and areas of activity to secure a revenue stream for the future. The real impetus is not from cash equities; it is very much about clearing, OTC, potentially, fixed income markets and looking at what they can do in more commercial areas.
Net Gain/Loss from Exchange Mergers
We would hope to see technical enhancements at the exchanges. By applying a rule of best practices, the things that work well for the Toronto Stock Exchange or the London Stock Exchange could be transported to the other exchange, as with Deutsche Boerse and NYSE Euronext. The technical platforms and order book layout are quite relevant, so we would hope to see some enhancement in that area. Nonetheless, I would not necessarily promote a uniform market layout or order book structure, as I do not think we need that in every single exchange we trade on. To some extent, the more that order books’ structures align, the more it helps traders who are trading multiple markets. We can pre-constrain a lot of unique exchange rules in our systems, but there are segments where human intelligence and manual control of the various elements are vital. In this respect, we would see any alignment of market practices as a fairly positive development.
The obvious potential negative outcome of the mergers is in returning to situations where the exchanges have too much of a monopolistic position and can potentially raise costs without the market having any ability to challenge it. If the MTF’s or exchanges raise their costs, we do not necessarily see that on the buy-side because of the buffer that the broker provides. There is a fairly high margin in the commission rates we pay our brokers and they cover their costs of trading our orders on the venues, and those venue transaction prices would have to increase exponentially for it to become a direct factor for us. Of course, it does eat away at margins for the brokers, and it may come to a point where they need to pass those costs on. The buy-side is somewhat safeguarded from rising venue costs, but not completely.
BT’s Chris Pickles charts the history and structure of German exchange networks.
Wherever you may be from, when you arrive in another country you often find yourself comparing how things are done in the local market, to how they are done at home and in Germany, there is usually a very good reason for what they do in the financial markets. Germany is probably unlike any other financial market in Europe. As the largest single national economy inside or outside the European Union, it has its own dynamism and momentum that can follow the flow of the rest of the world or take its own direction when it sees that a different approach is needed.
The structure of the market is different for many reasons. Germany is a federation of states, each of which has its own government and economy, and until recently each of the “old states” of western Germany also had its own stock exchange. Those eight exchanges competed headto-head for order flow, and it was only some twenty years ago that the Frankfurt Stock Exchange grew from being the number two stock exchange in Germany to become the largest of the German stock exchanges and a leading world exchange. But the other German stock exchanges – Dusseldorf, Munich, Hamburg & Hannover, Berlin and Stuttgart – are still actively competing in the market.
Bonds trading has always been a major service area for German stock exchanges. As a result, the concept of integrating trading and trade-related services horizontally across asset classes and vertically down the STP (Straight-Through Processing) chain to provide more cost-efficient solutions for the local financial community has been an underlying principle behind the development of all financial trading in Germany. That has led to a different market expectation of how technology, connectivity, networks and standards are applied.
Central to the architecture of the German securities and derivatives markets is Deutsche Boerse Group, which operates the Frankfurt Stock Exchange and Eurex, the German derivatives exchange. This Group also includes Clearstream, which is the domestic Central Securities Depository (CSD) as well as being an international CSD. And the group also includes Eurex Clearing as the Central Counterparty (CCP). Deutsche Boerse Group is not, as the name would imply, the German exchange, but it includes almost all of the central functionality that a domestic market participant would need in order to domestically trade securities and derivatives.
German securities exchanges have continued to offer floor trading right up until today, and many TV stations around the world that want an image of “real people trading” tend to use a picture of the Frankfurt exchange floor – no matter what market they may be talking about. Order matching has remained a fundamental of German securities trading. While the USA went to quotedriven markets, and the UK used “Big Bang” to move to a single quote-driven exchange, Germany continued to use competing order-driven markets to deliver cost-efficient trading to investors. That may sound conservative, but as a counter-argument, the London Stock Exchange has re-introduced order matching and this now processes greater trading volumes than its quote-driven system.
When the German exchange systems were being developed, ISO industry standards for securities messaging and market data were in their very early days, and were not truly “fit for purpose”, so that any exchange system that wanted to use ISO message standards had to apply work-arounds, typically using free-text fields to try to make up for the inadequacies of the standard formats. As an example of how cooperation can sometimes be better for markets than pure competition alone, the German exchanges jointly created BrainTrade, which operates the Xontro national order routing/matching system, which offered the FIX Protocol as the interface standard for use by the German trading community. FIX was first introduced by Deutsche Boerse as a commercial product running at the customer site on top of the legacy interface VALUES, although take-up was limited.
The FIX Protocol is also now being applied by Deutsche Boerse for users of its Xetra securities trading systems and its Eurex derivatives trading system, initially as a front-end to its high-speed proprietary protocol ETS. This will allow member firms to apply their existing use of the FIX Protocol to both Xetra and Eurex, but only where latency is not considered to be critical. The next stage will be to offer a native interface supporting FIX semantics over a high-speed transport in the context of new platforms for trading and clearing. This will provide performance as well as simplicity of access, starting with Eurex and followed by the Xetra trading system.
In this article, Nomura’s Ben Springett provides a brief overview of some of the key issues currently impacting European market structure, and shares his own thoughts on some of the changes likely to occur in Europe this year.
European market structure, has been, is, and will continue to be, in a state of change for the foreseeable future. Whilst European Commission regulation has been a significant catalyst in this, the industry itself is now looking to progress issues at a faster rate than the expected regulatory change. As such we are seeing increased interest in “self” regulation within the community, particularly in the areas of post trade reporting and efforts to provide a consolidated tape. All market participants are active in this, but it is not unreasonable to assume that it will be down to the broker-dealers to drive any change, as they typically are the ones that have the resources to invest in the process.
Market share amongst trading venues can be measured in many different ways and people can be forgiven from choosing one that paints their own venue in the best light. The accompanying two charts (Charts 1 and 2) show the steady decline of market share amongst the key primary exchanges, to the benefit of the MTF venues, although the total volume levels remain significantly lower than the pre-credit crunch days. When considering primary exchange volumes versus MTFs it is necessary to bear in mind that the primaries are only just starting to compete in each other’s markets, and as such the pan- European MTFs have had more blue chip names with which to capture their market share. This is set to change in 2010; Euronext launched ARCA last year, Xetra have launched their International Market (XIM) and the London Stock Exchange (LSE) have just completed the acquisition of a majority (51%) stake in Turquoise.
MiFID did not mandate a market- wide consolidated tape, as opposed to the NBBO ( National Best Bid and Offer) provided under Reg NMS, and the lack thereof is one of the key concerns raised by the buy-side in a range of forums. There is however, no significant issue with data aggregation offered by a number of key providers such as Bloomberg and Reuters; in addition to some strong fragmentation analysis products available to the market (Fidessa Fragulator, BATS Europe).
In a period of time where cost base is under increasing pressure, attention has now been drawn to the inherent impenetrable conditions that exist in market data (the LSE has sole distribution rights on LSE data, Deutsche Boerse on Deutsche Boerse data etc.), and as the number of venues from which the data is required for increases, so will the interest placed on the associated charges. In an environment with considerable focus on competition, competitive forces cannot work to reduce the fees, leaving regulation as the only option, which was again addressed under Reg NMS in the US.
High Frequency Trading (HFT) is creating waves the world over, and Asia is no exception. With the challenges HFT presents being highlighted by many, and the benefits it offers markets being stressed by many others, Ronald Gould, Chief Executive Officer, Asia Pacific, Chi-X Global, focuses on their likely prospects in the enticing markets of China.
Developments in market structure generally occur in conjunction with three things. First, such developments require a receptive regulatory environment, one that permits change and encourages innovation. The second requirement is trading venue technology, generally coupled with the existence of more than one trading venue. Trading technology availability is improving but it would be wrong to suggest that markets everywhere are equal in this respect. Finally, there needs to be a user environment that is supportive of market change and willing to help drive innovation. These ingredients are observable in varying measure across markets in Asia, some at the forefront of change and others warily fighting against it. In most places in Asia, the current status of market change is in limbo as a result of hesitance on the part of one party or another to begin the process. Our own experience indicates that Japan, Singapore and Australia are leaders in this change while others are either cautious or opposed.
If we survey the market structure scene in Asia, some places present a more ambiguous picture than others. One of the most intriguing and perplexing pictures is China, a market filled with potential, intriguing to investors, clearly interested in innovation and change but whose plans and objectives are often opaque to the outside world. Given China’s growing importance to investors, an effort to make the picture of change clearer must be a useful one. First, it is helpful to establish a baseline from which to start, a description of the situation today.
According to figures published at the end of 2009 by the World Federation of Exchanges (“WFE”), China is now the world’s second biggest equities market based on total market capitalization. Free float is much smaller however, as both State and corporate holdings are still substantial. The market is heavily dominated by retail investors, of whom there are more than 50 million with active accounts and more arriving daily. Institutional investing is at an earlier stage although mutual funds have grown rapidly and Exchange Traded Funds (ETF’s) represent a major growth area as well. Because many of China’s largest companies were previously state owned and with shareholding still tightly controlled, turnover rates among institutional investors are very low. While a block trading facility exists in Shanghai, it is not as yet widely used and probably needs upgrading if it is to attract a greater audience among investors. The new generation trading system for the Shanghai Exchange was launched in Dec 2009, purchased from Deutsche Boerse and adapted with the help of Accenture for rather different market conditions over several years. Latency is not something that gets much scrutiny by investors in Shanghai but it is not a characteristic as yet highly valued. The question we confront today is whether we are at an inflection point for change in China, a point at which the instinct for innovation begins to drive a greater openness. Let’s look at the evidence.
Kevin McPartland, Senior Analyst, TABB group explains the metamorphosis of the Exchange today and how the very definition of an “Exchange” is being transformed.
High frequency traders are not the only ones trying to get faster. The last few years have seen exchanges enter an arms race for speed that rivals the most sophisticated trading shops in the world. The focus on reducing latency and increasing bandwidth is so extreme that we are watching the definition of“Exchange” transform right before our eyes. Not because physical trading floors in city centers have been replaced with massive data centers in out–of-the-way industrial areas, but because the exchange business model has fundamentally changed from one that is transaction-based to one that is technology-driven. The reasons why are quite simple. Execution fees have been driven down by competition largely brought on by field-leveling regulations (read Reg NMS and MiFID) enabling competition and in turn making technology, the real differentiator. The exchanges are desperate to both retain and attract more liquidity, but with execution fees often below zero and market monopolies consigned to history, only a serious investment in technology will ensure life throughout the next decade and certainly investments in technology are being made.
The most serious technology investments have been made by the world’s largest equity exchanges. NYSE Euronext purchased Wombat and NYFIX among others to create the newly branded NYSE Technologies, NASDAQ merged with OMX to create an exchange technology provider with global reach, the London Stock Exchange (LSE) recently purchased MillenniumIT to rebuild its matching engine and be its technology arm, and the Deutsche Boerse has long been a technology provider in its own right. Chi-X, the largest multi-lateral trading facility (MTF), has a separate technology arm in the form of Chi-Tech. Most recently, the Tokyo Stock Exchange (TSE) launched its long awaited Arrowhead platform with hopes of entering the low latency trading world. CME Group, BATS, and numerous others have also invested heavily in ensuring they have the latest and greatest technology. Some are working to maintain their dominant market position and the others are continuing their quest to take liquidity from the incumbents.
Exchange differentiation under the new paradigm is not easy. Twenty years ago NYSE traded NYSE listed securities and OTC securities were traded via NASDAQ; shares in UK based companies were traded on the LSE, shares in German companies were traded on Deutsche Boerse, and so on. Now, especially for US and European equities, shares of anything can be traded virtually anywhere. I’m over-simplifying of course, but with globalization flattening the world of stock exchanges, regulations keep everyone on a level playing field and with all measuring speed in microseconds the only obvious differentiator left is the name of the venue. Even if we assume traders naturally migrate to where liquidity is deep and spreads narrow, only through an understanding of exchange technology can one rationalize what causes that situation to occur.
It is a poorly kept secret that high frequency trading firms and proprietary trading desks at investment banks co-locate to shave off microseconds. This practice is at the heart of exchange-client connectivity. These high speed orders are generated within the servers of proprietary trading desks and hedge funds, and are sent via a high speed network into the exchange’s matching engine, all literally residing under one roof. This practice generates the majority of order volume in the US and increasingly in Europe.
Large agency orders from traditional buy-side sources are also important to an exchange’s success, but it is more often the job of the broker to ensure connectivity to the data center for their client flow. Simply put, the sell-side handles inter-data center connectivity and the exchanges handle intra-data center connectivity. TABB Group estimates that North American spending on market connectivity sits at just over $2 billion annually, with 70% of that number coming from the sell-side.